Coeur Report: Q1 2023

If we were to pick a theme for Q1, it would have to be “customer credit.” At least within the (very) small universe of our portfolio, there was a marked credit change between December 2022 and January 2023.  A number of the account debtors (our client’s customers) that had medium to low credit ratings in our system began to pay more slowly.  In certain cases, the payment delay was pretty straightforward – invoices were still paid but the account debtor changed its payment terms from say 30 days to 60 days or 60 days to 90 days.  Changes like this happen all of the time on our portfolio on a one-off basis, but the movement here in Q1 was concerted rather than isolated to one or two credits. 

More damaging from our perspective were the ways in which certain account debtors “unofficially” changed their payment terms.  Usually, this is effected by the account debtor disputing an invoice that they normally (in better times) would accept without comment or by “losing” the invoice when it came due for payment (an accounts payable version of the “dog ate my homework”).  These cases are more difficult to diagnose – was it our client’s fault that the billing was lost or is the account debtor playing tricks on us?  The key point is that most companies don’t want to admit that they are having trouble paying their vendors.  Even the companies that change their official payment terms don’t say, “We’ve changed our payment terms because we recently realized that we are running out of cash!”  So, it is on the vendors (our clients) and on us to read between the lines. And, let me tell you that if a company that owes you a lot of money is regularly “losing” your invoices, it is having liquidity issues. 

The worst account debtors of all are those in financial difficulty who are actively seeking to take money back from their vendors.  Usually, these are mid-sized, private companies, and there is a particularly high concentration of them in the construction field.  These companies need to be avoided at all costs; they can usually be identified because they are applying hard to understand deductions to their vendors invoices on a repeated basis.

And, finally, there is the troubled account debtor who continues to pay right on time and in full…right up until the day that they file for bankruptcy.  We had a client a year or two ago that was selling to Party City, and even though Party City’s stock price was dropping like a stone at the time (much to the concern of @budcrawford), Party City’s accounts payable process was perfect – our client was paid right on time.  These situations can lull a small vendor (and for that matter its finance company) into a false sense of security.  As someone who bought Lehman Brothers stock in August 2008, I find that I am particularly susceptible to the siren song of “too big to fail.”  But, there are clear warning signs that all is not well even though payments continue to come in – the clearest being that the company’s stock price and debt rating (note: these are nearly always public companies).  It is our belief that if a company is rated B1 or below, it isn’t worth selling to – a small vendor cannot be a distressed debt hedge fund (with the possible exception of our old client Andy DeSimone).   In a particularly recent example, our credit insurer canceled coverage this week on a large cable company whose credit rating had fallen too low in the insurer’s estimation; the intelligent vendor will take heed of a sign like this and start the process to move its business elsewhere, even if it seems to be impossible for him to conceive of his business without the big cable company at the time.  Those that don’t make the change will likely file bankruptcy shortly after their big vendor does.

Whatever the symptom, we think that the cause of the slowdown in payment terms at this time is the same in most cases: higher interest rates.  Your economic textbook will tell you that higher interest rates slow the growth of the economy – I had always processed that idea as “fewer investments in new projects because the cost of new debt is more expensive.”  But, we see the other side of the coin with troubled companies.  If a troubled company is borrowing at floating interest rates (mid-sized and smaller companies mostly), they truly have less free cash today than they had one year ago because more of their cash is absorbed by interest expense. So, these companies borrow from their vendors by pushing out payment terms or (in the most extreme cash) squeeze margin out of their vendors by deducting from their invoices.  In the case of the of the big public company, the problem manifests a little differently because some of big public co’s borrowing is done at fixed costs and their debt matures in tranches on well known dates in the future.  For these companies, maybe their borrowing costs don’t change meaningfully right away, but one day, a big debt maturity comes along, they cannot refinance the cheap old debt with more expensive new debt and “poof” they are insolvent. 

What is a small vendor like one of our clients to do in these more treacherous times?  The easy to say, hard to do answer is: find good clients.  There is a “flight to quality” for investors in more troubled times, and for vendors it should be the same.  The strong companies will be the ones that continue to build new things when interest rates are high and that will still need software and IT services and janitorial services and everything else.  So, go out there and get that contract with Verizon or Microsoft that you always wanted. 

If you are a small vendor that all of a sudden has shaky customers, the adjustment to stronger customers will be hard at first.  All of your competitors will also be trying to work with the stronger companies.  The competition may affect your margins, and it will certainly require that you get out and sell (which takes a lot of effort for business owner that may also be in charge of day-to-day operations).  But, it is better than doing work and not getting paid for it.

Best wishes for a great Q2,

Brendan Dete